Simple option trading question...

[ironchef]

drcha,

Thank you for your answers. I do have McMillan's book and will reread that section.

I did try roll-up to take profit on some of my trades but I was not getting any benefit of roll-up as they were all rolled to ATM/OTM and most expired worthless with the outcomes about the same as buying a protective put. I guess the market is efficient in that sense and the market makers really knew what they were doing.

 

[drcha]

I agree the market is pretty efficient. That is why I have never gone along with the "blindly sell theta" crowd. One has to have a correct idea about direction of the UL or direction of volatility to make money.

 

[ironchef]

drcha,

I reread McMillan's section on Call Buying and following the book's example, I created two matrices of potential profit/loss, one at the time of purchase of the options and two at the time I needed to consider follow up actions: take no action, take profit, roll-up, spread, collar and take partial profit (the last two I added per some of the comments I got from this forum). If I did that in Feb or May, taking partial profit or did a spread would be the two intelligent things to do vs exiting or doing nothing. I now get a sense of what actions I could take. You were correct to say the answer depended on many factors.

As you also said, having a sense of the direction of the UL and the direction of volatility was important. I can't thank you enough for your coaching. You, xandman and VIXTrader all have a lot of wisdom and folks like me benefited from your willingness to comment/help.

Regards,

 

[ironchef]

A partial hedge:

Bought a long GOOGL ATM Call prior to earning, sold an ATM Call when GOOGL went up $100 on 7-17 to lock in some profit. Bought back the short yesterday to capture the hedge profit and eliminate the upside limit to bet on bullish GOOGL as long Call has some time left?

Any other ways to handle this long Call?

 

[OddTrader]

IMHO, there are no inexpensive hedges, and the best hedge is not to get too big. A long call is a hedge in itself, yes? It could be considered a substitute for buying a stock and a put.

A good question indeed! And a good answer is also supplied!

 

[ironchef]

A good question indeed! And a good answer is also supplied!

I did take drcha's advice and completely exited that GOOGL long Call when it gapped up again to $795 in December. drcha made some invaluable comments and advice to me.

Also, I think I got lucky and remembering the RIG lesson, decided not to be too greedy.

 

[El OchoCinco]

Moneyness is a question of sensitivity. ITM options with higher deltas have higher deltas and thus move more in line with the underlying but cost more. OTM options cost less but are less sensitive to moves in the underlying unless the underlying starts to move. ATM is a balance of delta/gamma.

Which one is the right one? Well they are all right depending on your outlook on the underlying, the magnitude of the move you expect, and the time frame in which you expect it to move. Once that is explained then we can address time decay of each type.

Options are like chess, you have to think in 3 dimensions in many ways. Answer the above questions first and then we can better offer guidance on which options match your expectation somewhat better but always knowing there is no specific definitive right answer...

 

[blueplayer]

Moneyness is a question of sensitivity. ITM options with higher deltas have higher deltas and thus move more in line with the underlying but cost more. OTM options cost less but are less sensitive to moves in the underlying unless the underlying starts to move. ATM is a balance of delta/gamma.

Which one is the right one? Well they are all right depending on your outlook on the underlying, the magnitude of the move you expect, and the time frame in which you expect it to move. Once that is explained then we can address time decay of each type.

Options are like chess, you have to think in 3 dimensions in many ways. Answer the above questions first and then we can better offer guidance on which options match your expectation somewhat better but always knowing there is no specific definitive right answer...

The question that everyone asks all the time is what is the best strike and expiration to play a given move. At least that is the question that everyone ask me all the time, so I decided to write a simple long gamma optimizer that would pick the best option based on the thesis being tested, of course you need to have a thesis first:

1. Magnitude of expected move
2. Time frame of the expected move.
3. Stop point (how many points against are you willing to take)

If you have those pieces of information then you can maximize the gamma gains (if playing long gamma is your thing). From the numerical simulations and real life experience here a few quick conclusions:

1. ITM options have little to no optionality, so using them is more or less like using the underlying, just with a bit of downside protection.

2. Long gamma trades work best when the timeframe is very short (1 or a few days tops), if the timeframe is too big (months or so) then any optionality advantages get lost due to the variance risk premium present in the option price.

3. Options with very little time on them, while providing a nice percentage return when the move is right, have a terrible Risk Reward multiplier.

If you want to experiment yourself please play with the optimizer here:

http://gamma-trader.shinyapps.io/demo/

Let me know if you have any questions

 

[ironchef]

Moneyness is a question of sensitivity. ITM options with higher deltas have higher deltas and thus move more in line with the underlying but cost more. OTM options cost less but are less sensitive to moves in the underlying unless the underlying starts to move. ATM is a balance of delta/gamma.

But when I used BS to calculate the percentage change in option prices, using the same (small percentage) delta changes in moneyness (d Call Premium/d Moneyness) and keep all other parameters the same, OTM had higher percentage movements than ITM. Which means if I don't hold my position to expiry, I have a better chance of exiting my position with higher profit with OTM than ITM?

 

[ironchef]

2. Long gamma trades work best when the timeframe is very short (1 or a few days tops), if the timeframe is too big (months or so) then any optionality advantages get lost due to the variance risk premium present in the option price.

Can you kindly explain this point.

Thanks.